Questioning H2Diesel's Market Prospects

Today’s whipping boy is H2Diesel Holdings Inc. (HTWO.OB). I do not believe that the company’s product, a new method for making biodiesel, can possibly work. It would be great if it worked, but a cursory reading of the company’s description of the process makes no sense whatsoever to anyone who understands chemical manufacturing.

From the company’s website:

Unlike the complex transesterification process used by most Biodiesel producers H2Diesel’s Biofuel is manufactured using a simple blending, or emulsification process. Water is blended with a combination of commonly available chemicals to make a proprietary additive. The additive is blended with vegetable oil feedstock (commodity or waste) to produce the H2Diesel Biofuel. There are no significant by-products from the process.

From their comparison of H2Diesel to normal biodiesel:

H2Diesel biofuel is manufactured using a simple mixing process, using little energy and yielding virtually no by- products.

In the real world, there are very few chemical reactions without significant byproducts. Furthermore, transforming vegetable oils into diesel using any proven method uses significant amounts of energy, yet H2Diesel claims that their process uses very little. This indicates to me that the company does not know what they are talking about and that the method does not work as they indicate. This product is about as likely as perpetual motion machines.

Management Has Little Chemical Experience

I would expect the management of a research company that is revolutionizing chemistry to have a lot of chemistry research experience. Only one of H2Diesel’s top executives has any research experience, and only received his PhD in 2006. All the other executives have financial backgrounds.

Furthermore, the company has spent a total of only $287,000 in R&D since inception in 2006 (see p4 of the most recent 10Q). That is barely enough to support one full time research chemist and necessary chemicals, let alone the cost of analytical equipment.

I should add that the company acquired the exclusive license to their biodiesel production method from an Italian chemist (see the 2006 10-k for details). If the product was perfect when they licensed it, there would be little need for additional R&D expenditures. However, for most chemical products it takes significant R&D to turn a laboratory-proven technique into a commercially-viable technique.

Valuation: Losses, No Assets, Big Market Cap

According to the most recent 10Q, as of August 10, 2007, H2Diesel had 17,266,150 shares outstanding. However, the existence of the company’s Preferred Convertible A stock increases the fully diluted share count by 1,063,750. Warrants from the convertible preferred stock offering add an extra 531,875 fully diluted shares. At a recent price of $7 per share, the company has a fully diluted market cap of $188.6 million. (There are also at least 1.5 million other warrants outstanding that I do not include because they are performance-based for a consulting contract).

Also as of the most recent 10Q, the company had book value of $3.8 million and a loss in the previous 3 months of $3.7 million.

Big Name Partner Lends Credibility?

The company is having an affiliate of Dynegy (DYN) - market cap of $7.862B - do a test-burn of some of its biodiesel. This seems to lend credibility to the company. However this appears to be a no-lose situation for Dynegy–it foots a few small costs and gets some free fuel.

Fuel is Not EPA Approved

The company’s biodiesel does not meet EPA standards for use as a fuel for vehicles. This means that the largest market for diesel fuel is off limits for H2Diesel for the time being.

From the company’s 2006 10K:

We intend to market the H2Diesel Bio-fuel as a new class of bio-fuel or fuel additive for power generation, heavy equipment, marine use and as heating fuel. We have evaluated whether the H2Diesel Bio-fuel can be formulated to comply with U.S. Environmental Protection Agency (“EPA”) standards to be classified as “Bio-diesel” for vehicular use. EPA standards mandate that “bio-diesel” comply with the specifications of the American Society for Testing and Materials [ASTM] 6751. In particular, ASTM 6751 requires that the fuel be comprised of “mono-alkyl esters of long chain fatty acids.” The H2Diesel Bio-fuel does not comply with this specific requirement of ATSM 6751, and consequently, it is not compliant with EPA standards. However, we are currently investigating whether the ASTM standard can be broadened to include our fuel. Additionally, we are evaluating the regulatory requirements for using our fuel in motor vehicle applications in our territory outside of the United States.

Conclusion

H2Diesel is speculative at best and utterly worthless at worst. I cannot imagine any reasonable investor buying the company’s stock.

Disclosure: I hold no position in DYN or HTWO.

Comments

[Bubba]

"Furthermore, transforming vegetable oils into diesel using any proven method uses significant amounts of energy"

I guess you missed that episode of Mythbusters - you can run waste cooking oil through a paper filter and put it straight into a diesel automobile engine. The only significant amount of energy required is to move waste cooking oil from the source to your facility.

[MichaelGoode]

You make a good point. However, this is chemically quite different from normal diesel fuel or biodiesel. This can damage normal diesel engines. See www.caranddriver.com/a...

[unreal]

snake oil sales in the 21st century??

[EJ1962]

Michael,
This company is about burning vegetable oil in diesel engines, so you don't a chemical reaction.

What bothers me about them is that they create an emulsion: a mixture of 2/3 vegetable oil and 1/3 water with some other 'secret' ingredients. Water, of course, doesn't burn, so their fuel has 1/3 lower energy content per gallon than biodiesel, a significant disadvantage if you need to distribute this stuff or carry it in the fuel tank of a truck or ship.
Also, does this emulsion separate after storage, requiring careful mixing/stirring to use?
Finally, what are the economics of this product? For one, you rely on vegetable oil being cheaper than (low grade) diesel fuel.
However, air pollution credits and subsidies may help with the economics.
So, lots of questions and not much information from this company, and therefore not worthy of investment right now.

[MichaelGoode]

Thanks for making some good points.